The 5 new reverse mortgage rules
Silver-haired celebrities tout them on TV and lenders mail colorful pamphlets promoting their benefits. The promotion is clearly working. More than 660,000 reverse mortgages were issued between 1990 and 2010, according to AARP.
But the loans are risky, both for the borrower and the federal government, which insures nearly all reverse mortgages.
Because of increasing defaults, the federal Home Equity Conversion Mortgage program — the formal name given to reverse mortgages — has seen huge deficits.
In July, Congress passed the Reverse Mortgage Stabilization Act, giving the Federal Housing Administration the power to make changes to the program, which allows homeowners over the age of 62 to withdraw equity in their homes while deferring repayment until the house is sold or the owner dies.
The new rules, rolled out in two phases beginning this fall, are designed to stabilize the program, minimizing the risk and reducing default rates.
If you’re planning to apply for a reverse mortgage, here are five things you need to know about changes to the program.
Under the new rules, the former "standard" and "saver" options will be rolled into a single product.
While the amount a homeowner can borrow remains tied to their age, current interest rates and the value of their home, FHA has cut the percentage of equity you can remove from your home through a reverse mortgage. The new limit went into effect Sept. 30.
A 65-year-old borrower with a home worth $100,000 and an interest rate of 5% could withdraw $54,100 — about 15% less than the limit for the former standard product, according to Peter Bell, president and CEO of the National Reverse Mortgage Lenders Association.
"(Borrowers) who need the whole amount of money to pay off debts won’t be able to use a reverse mortgage to do it," Bell says.
As of Sept. 30, HUD also has limited the amount of cash that can be withdrawn in the 12 months following reverse mortgage approval.
A homeowner who qualifies for a $100,000 reverse mortgage will only be allowed to withdraw 60% of their available equity, or $60,000 during the first year. The remaining equity can be accessed at the end of the 12-month period.
Previously, a homeowner could withdraw 100% of their available equity right away.
There are exceptions to the 60% rule.
Homeowners who have "mandatory obligations" like an existing mortgage and delinquent federal debts must use their equity to pay off those debts, says Gregg Smith, president and COO of San Diego-based One Reverse Mortgage. Credit card debt is not considered a mandatory obligation.
If those mandatory obligations exceed 60% of their equity, the homeowner may be allowed to take out additional up-front cash.
For example, a homeowner who qualifies for a $100,000 reverse mortgage and has an unpaid mortgage balance of $70,000 and $10,000 in student loans can access $80,000 to pay off debts and an additional 10% or $10,000 in cash during the first year.
Default rates on reverse mortgages hit 9.4% in 2012 — almost double the default rate on traditional mortgages — according to the Consumer Financial Protection Bureau, leading the FHA to take steps to ensure reverse mortgage borrowers have the funds to cover property taxes and insurance for the life of their loan.
Starting in January 2014, borrowers must undergo a financial assessment to qualify for the loan, which includes an analysis of mortgage debts, payment history and confirmation of up-to-date insurance policies. The assessment also will check for unpaid liens against the property and delinquent or defaulted debts owed to the federal government.
Lenders today don't check credit reports or analyze an applicant's financial situation, one factor contributing to defaults.
Even so, this new rule could mean some borrowers who would have won reverse mortgages in the past may be rejected.
"A lot of vulnerable seniors are house rich but cash poor and can benefit from timely access to home equity," notes Amy Ford, director of reverse mortgage council services network for the National Council on Aging. "(A financial assessment) could squeeze out low- to moderate-income borrowers."
To reduce default rates by ensuring borrowers have the funds to cover property tax and insurance, some borrowers will be required to set aside additional cash (similar to an escrow account) as part of a new rule that goes into effect in January.
A single homeowner with a minimum of $529 remaining each month after paying their expenses likely will not be required to set aside funds for property taxes and insurance, according to a HUD letter sent to borrowers. (Couples and families will have to show additional income to avoid the set-aside requirement).
Borrowers who don’t meet the minimum income requirements will either be required to set aside funds to cover property taxes and homeowners insurance for the life of the loan, called a Lifetime Expectancy Set Aside, or have these fees withdrawn from monthly reverse mortgage payments they receive.
New fees are based on the amount of equity a homeowner withdraws.
Borrowers who withdraw more than 60% of their equity in the first year of the loan will pay an up-front mortgage insurance premium equal to 2.5% of the appraised value of their home; the premium is 0.5% for borrowers who withdraw less than 60% of their available equity in the first year. (The previous fees were between 0.01% and 2%).
Borrowers also are required to pay an annual mortgage insurance premium, which remains at 1.25% of the loan balance.
"Even small changes in the fees will have a big impact on borrowers," notes Erin Rearden, a mortgage services program supervisor for Solid Ground, a nonprofit HUD-approved mortgage counseling agency in Seattle. "The drawback of financing these costs is that (borrowers) incur interest on the amount until the loan is paid."
This could leave the homeowner with little or no equity when they sell the home or die.